Published Tuesday, Oct. 18, 2016 6:40PM EDT
As the dividend investor with The Globe and Mail’s Strategy Lab series, one of my ongoing frustrations is that I’m limited to 12 securities in my model portfolio. Unfortunately, this means I have to leave out some great companies.
Case in point: Algonquin Power & Utilities Corp.
I already have two utilities – Fortis Inc. and Canadian Utilities Ltd. – in my Strategy Lab portfolio, and adding a third would be overkill. But I’ve held Algonquin personally for several years and been pleased with its performance. And analysts say the Oakville, Ont.-based company has a bright future thanks to its growing utility and power operations.
I’ve written about Algonquin several times before, and today I’ll provide an update on what I like about the company. Remember to do your own due diligence before investing in any security.
It’s relatively low risk
As its name implies, Algonquin is really two companies – a renewable power producer (Algonquin Power) that owns wind, hydro, solar and thermal generating plants across North America, and a utility (Liberty Utilities) that distributes electricity, gas and water in 34 U.S. states. The generating operations benefit from having 85 per cent of their output contracted under power purchase agreements with an average life of 14 years, which contributes to earnings stability. And because the utilities are regulated, they also produce relatively predictable cash flows. Algonquin isn’t without risks – a rise in interest rates, for example, could hurt the unit price – but the stable nature of the company’s earnings puts it at the lower end of the risk scale.
The business is growing
Algonquin has made nine utility acquisitions since 2009. Its most recent – and largest – is the pending $2.4-billion (U.S.) acquisition of Joplin, Mo.-based Empire District Electric Co., which is expected to close in the first quarter of 2017. The deal will add 218,000 electricity, natural gas and water customers in four states – Missouri, Kansas, Oklahoma, and Arkansas – to Algonquin’s current base of more than 560,000 utility customers. On the power generation side, the company has made six acquisitions since 2009 and has six projects under construction or in development that will add more than 500 megawatts of power output to its current capacity of 1,385 MW. Algonquin also has opportunities to grow by investing in its utilities, thereby increasing the asset base on which its regulated returns are calculated.
Earnings – and dividends – are rising
Algonquin’s bottom line stands to benefit from all of this growth. Raymond James analyst David Quezada, who recently initiated coverage of Algonquin with an “outperform” rating and a target price of $14.50 (Canadian), forecasts that earnings per share and funds from operations per share will grow at compound annual rates of 13.6 per cent and 17.5 per cent, respectively, from 2015 to 2018. For dividend investors, this is a positive sign.
“We believe this supports the company’s stated target of 10-per-cent annual dividend growth, which places it well ahead of its utility peers and towards the higher end of the independent power producer group,” Mr. Quezada said in a note to clients. The fact that Algonquin yields 4.8 per cent – well ahead of the Canadian utility average of about 4.1 per ent – makes the stock look even more compelling to income investors seeking a solid, and growing, dividend.
The stock is reasonably priced
Algonquin trades at about 16.9 times estimated 2018 earnings, slightly above the peer group average of 16 times, Mr. Quezada said. However, he said the “premium … is warranted, in our view, given the company’s growth profile.” What’s more, assuming Algonquin raises its dividend by 10 per cent in 2017 and its yield were to fall to the industry average of 4.1 per cent, it would imply a stock price of $15 a share. (Algonquin closed on Tuesday at $11.58 on the Toronto Stock Exchange). “Accordingly, while we regard valuations in the utilities space as relatively expensive by historical standards, we highlight Algonquin as an exception and see further upside in the name,” he said.
Algonquin isn’t just an income stock or a growth stock – it’s both. That combination appeals to me as an investor looking for growing income. Analysts are also generally bullish on the shares. Of the 11 analysts who follow the company, there are 10 “buys” or equivalent, zero “holds” and just one “sell.” The average 12-month price target is $14.25.
“We believe AQN has the potential to deliver strong, sector-leading returns, and it remains one of our preferred names in the sector,” analyst Bill Cabel of Desjardins Capital Markets said in a recent note. “It offers long-term stable operations combined with significant growth and the strong likelihood for continued annual dividend increases to fuel further share price appreciation.” There may not be room for it in my model portfolio, but as long as the company continues to deliver solid results, I expect to hold the stock personally for many years.